Demographic Change and Entitlement Disaster

Imagine that we’re in a parallel universe and that you’re the lookout on the Titanic. But in this make-believe world, you have all sorts of fancy radar that allows you to detect icebergs with lots of advance notice. Furthermore, imagine that you detect danger and give lots of warning to the Captain and other officers.

Simply stated, welfare states were created back when everyone assumed that there would always be a “population pyramid,” which means relatively few old people (who collect a lot of money from entitlement programs) at the top, plenty of workers (also known as taxpayers) in the middle, and lots of children (i.e., future taxpayers) at the bottom.

In that world, a modest-sized welfare state isn’t a good idea, but at least it is mathematically sustainable.

At the risk of beating a dead horse, here’s some additional data on this global problem. We’ll start with this look at how the population pyramid is becoming a population cylinder. The key thing to notice is the growth of the over-65 cohort.

And here’s a different way of looking at the same data, but stretching out to 2100.

I didn’t add a red line at age 65, but it’s easy to see that the number of older people will dramatically increase without a concomitant increase in the number of working-age people who are expected to pay the taxes to finance pensions and health care.

The ageing populations of the advanced economies and the larger emerging ones combines with past falls in the birth rate to mean that the share of total world population who are of prime working age has been falling since 2012. After a four-decade rise, the trend has reversed with that fall projected to last throughout the 2020s, 2030s and 2040s. A slower-growing global workforce will be a big challenge for the global economy.

A “big challenge” may win the prize for understatement.

Bloomberghas a column on the implications of this massive demographic shift. Notice the data on the number of workers per retiree in various nations.

Rising dependency ratios — or the number of retirees per employed worker — provide one useful metric. In 1970, in the U.S., there were 5.3 workers for every retired person. By 2010 this had fallen to 4.5, and it’s expected to decline to 2.6 by 2050. In Germany, the number of workers per retiree will decrease to 1.6 in 2050, down from 4.1 in 1970. In Japan, the oldest society to have ever existed, the ratio will decrease to 1.2 in 2050, from 8.5 in 1970. Even as spending commitments grow, in other words, there will be fewer and fewer productive adults around to fund them.

The bottom line is that there are enormous unfunded liabilities.

Arnaud Mares of Morgan Stanley analyzed national solvency, or the difference between actual and potential government revenue, on one hand, and existing debt levels and future commitments on the other. The study found that by this measure the net worth of the U.S. was negative 800 percent of its GDP; that is, its future tax revenue was less than committed obligations by an amount equivalent to eight times the value of all goods and services America produces in a year. The net worth of European countries ranged from about negative 250 percent (Italy) to negative 1,800 percent (Greece). For Germany, France and the U.K., the approximate figures were negative 500 percent, negative 600 percent and negative 1,000 percent of GDP.

Wow, it’s depressing that the long-run outlook for the United States is worse than it is for some of Europe’s most infamous welfare states. Though I guess we shouldn’t be totally surprised since I’ve already shared similarly grim estimates from the IMF,BIS, andOECD.

I’ll close with some (sort of) good news.

Notwithstanding some of the estimates I’ve shared, America actually is in better shape than these other nations. If we enact genuine entitlement reform, ideally sooner rather than later, the long-run numbers dramatically improve because spending and debt no longer would be projected to rise so dramatically (whereas government already is an enormous burden in Europe).

This isn’t idle theory. Policymakers don’t have much control over demographics, but they can reduce the fiscal impact of demographic change by adopting better policy.

To cite the most prominent examples, jurisdictions such as Hong Kong and Singapore have very long lifespans and very low birthrates, yet their public finances don’t face nearly as much long-run pressure because they never made the mistake of setting up western-style welfare states.

The solution, therefore, is for America and other nations to copy these successful jurisdictions by replacing tax-and-transfer entitlements with systems based on private savings.

[…] in the United States. And France. And Germany. And Japan. Simply stated, the welfare state is becoming an ever-larger burden in large part because the elderly population is expanding in developed nations compared to the […]

Excellent article. It isn’t just the Trump administration that won’t fix this, it’s any administration. A leftist administration wants this disaster and a conservative administrationg won’t be allowed to fix it by the left, as long as they have the numbers in the Congress, they don’t want it fixed. Economic doom is part of the insane leftist Alinskyite plan to impose a worldwide socialist government under the auspices of the United Nations. It’s going to take a massive turnover in the Congress to get this fixed and that’s just not going to happen. I’m not optimistic about non-violent change in this nation. As for the rest of the world – I think it’s going to be a nightmare.

It should be added though that all PAYG pension systems have a built-in adjustment parameter, that is the pension age which triggers payments. That is why many ageing countries have already started this adjustment process quite some time ago (see, for instance, the 2005 paper – https://assets.aarp.org/rgcenter/econ/2005_16_oecd.pdf)

What cannot go on will not go on. As potential for growth keeps been suppressed by the redistribution necessary to sustain the aging welfare state, some country, and then more, will break out of it. Then, with increasing worldwide mobility, productive people will flock into those jurisdictions. America, with its worldwide taxation, will resist the trend a little longer, until the distortion pressure increases even more, and the inevitable implosion becomes all the more catastrophic.

Rest assured that in the next fifty years we will see unimaginable things in both the technological domain, and thus also inevitably in the social and political domain.

As I’ve said many times: Stay mobile.

PS. Predictions to 2100 are so dependent on the now exponentially accelerating technological change that any predictions will be blown out of the water — in either a good or bad way. In other words, much more dramatic changes will come much much sooner. For example, the increasing leverage of technology will widen prosperity disparity with some societies resisting it and thus failing to get onboard the exponentially accelerating train (or fall into outright pitchfork revolution) while others will see unimaginable exponentially growing prosperity — and longevity. That population pyramid or cylinder will be blown out of the water, and the wealth pizza will explode.

Or maybe I’m just too optimistic because it’s Friday…

PPS. The US has a more grim demographic balance outlook compared to the welfare states, but has a higher growth rate which will partially compensate for it. In other words, our tax payments are in the future, and in a way deferred taxation of growth is preferable to immediate taxation, which is essentially what the European welfare states already do by taxing now with their already high tax rates which they pay for in reduced exponential growth. But I agree the difference is not that significant in the end. Tax now, tax later, we are in more or less the same boat. The slow and slower growth boat.

PPPS. And just to sink my earlier optimism (at least locally for the US) after Trump there’s a Bernie Sanders like president in the cards. Again, stay mobile.